China Merchants Expressway Network & Technology HoldingsLtd (SZSE:001965) Has A Pretty Healthy Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, China Merchants Expressway Network & Technology Holdings Co.,Ltd. (SZSE:001965) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for China Merchants Expressway Network & Technology HoldingsLtd

How Much Debt Does China Merchants Expressway Network & Technology HoldingsLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 China Merchants Expressway Network & Technology HoldingsLtd had CN¥59.5b of debt, an increase on CN¥39.7b, over one year. However, because it has a cash reserve of CN¥6.60b, its net debt is less, at about CN¥52.9b.

A Look At China Merchants Expressway Network & Technology HoldingsLtd's Liabilities

We can see from the most recent balance sheet that China Merchants Expressway Network & Technology HoldingsLtd had liabilities of CN¥15.0b falling due within a year, and liabilities of CN¥57.3b due beyond that. Offsetting this, it had CN¥6.60b in cash and CN¥5.33b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥60.3b.

This deficit is considerable relative to its very significant market capitalization of CN¥84.5b, so it does suggest shareholders should keep an eye on China Merchants Expressway Network & Technology HoldingsLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Strangely China Merchants Expressway Network & Technology HoldingsLtd has a sky high EBITDA ratio of 8.8, implying high debt, but a strong interest coverage of 1k. So either it has access to very cheap long term debt or that interest expense is going to grow! Importantly, China Merchants Expressway Network & Technology HoldingsLtd grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine China Merchants Expressway Network & Technology HoldingsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, China Merchants Expressway Network & Technology HoldingsLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that China Merchants Expressway Network & Technology HoldingsLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its net debt to EBITDA has the opposite effect. We would also note that Infrastructure industry companies like China Merchants Expressway Network & Technology HoldingsLtd commonly do use debt without problems. When we consider the range of factors above, it looks like China Merchants Expressway Network & Technology HoldingsLtd is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that China Merchants Expressway Network & Technology HoldingsLtd is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.